John Hamilton

Misleading Marketing Materials: SEC Enforcement Lessons for Hedge Fund and Private Equity Firms

In two recent enforcement actions involving a hedge fund manager and a private equity sponsor, the SEC found violations of the Investments Advisers Act as a result of misleading information provided to investors in private fund marketing presentations.

In the Matter of Everest Capital LLC and Marko Dimitrijevic (April 30, 2020): Everest Capital Global Fund (the Fund), a hedge fund with AUM of $830 million at peak, was liquidated following losses sustained in January 2015 after shorting the Swiss Franc, which rose more than 30% in one day. While the SEC’s press release describes “misconduct relating to risk management,” the enforcement action is framed as a disclosure violation resulting from misleading information provided to investors in the Fund’s marketing materials.

  • Gross Exposure: Gross exposure numbers in Fund marketing presentations carved out currency positions without disclosing this fact. As a result, the Fund’s gross exposure was represented as ranging between 155 – 185% during the relevant period, when in fact it was over 1300%.
  • Concentration Limits: In addition, the marketing materials provided that the Fund “would not take concentrated positions in any single geographic region,” highlighting the lessons learned by Everest’s portfolio manager from taking concentrated bets on Russian investments in 1998. In fact, the Fund’s gross exposure to the Swiss Franc alone ranged from 400 – 900% during the relevant period.
  • Risk Management: The Fund’s marketing materials also described the ability of Everest’s risk team “to reduce risk independent of the investment team,” but in fact the risk team had no such authority with respect to the Fund’s currency positions. On this point, the SEC further points to the Fund’s offering memorandum, which “did not exclude currencies from the [firm’s] ‘extensive research and risk management.’”

In the Matter of Old Ironsides Energy, LLC (April 17, 2020): The Old Ironsides team formerly made energy investments for a Fortune 100 company and spun out in 2013 to become an independent energy private equity firm, with AUM of approximately $1.75 billion.  The firm was fined $1 million for mischaracterizing an investment in the team’s legacy portfolio, which formed part of the track record included in marketing materials distributed to investors.

  • In calculating the firm’s track record included in marketing materials distributed to potential investors in Old Ironsides Energy Fund II LP (Fund II), the firm described a large, profitable legacy investment made in 2002 as a direct oil and gas investment. In fact it was an investment in another private fund managed by a third party over whose investment decisions the team had only certain voting rights, along with other investors in that fund.
  • By including that private fund investment as a direct investment (specifically categorized as “early stage”), the firm improved the legacy portfolio’s track record in such investments, which would be one of three investment types on which Fund II would focus. Further, the SEC highlights that Fund II’s mandate expressly excluded investments in other private funds.

COVID-19 Checklist & Considerations for Private Fund Advisers

With COVID-19 concerns and market volatility, advisers should consider compliance challenges that are likely to arise. This COVID-19 Checklist & Considerations for Private Fund Advisers highlights key compliance issues, questions and considerations with respect to the COVID-19 outbreak and government response. Please note that if an adviser does not document its compliance efforts, the Securities and Exchange Commission (SEC) will assume that such efforts did not occur. This checklist is not exhaustive and does not, for example, cover Commodity Futures Trading Commission considerations, which are discussed in a separate client alert.

Authors:
Nicole Kalajian – Counsel, Chicago
John Hamilton – Counsel, New York
Prufesh Modhera – Chair, Private Funds Group, Washington, DC
Sara Crovitz – Partner, Washington, DC
George Michael Gerstein – Co-Chair, Fiduciary Governance Group, Washington, DC

Proposed Amendments to Issuer Disclosure: To ESG or Not to ESG

Proposed Amendments to Issuer Disclosure: to ESG or not to ESG

In connection with the SEC’s January 30 proposed amendments to certain of the financial disclosure requirements applicable to public companies under Regulation S-K, as well as accompanying guidance thereon, the separate public statements of Chairman Jay Clayton, Commissioner Hester Peirce, and Commissioner Allison Herren Lee underscore the continuing divide over the role of the SEC in disclosure related to ESG factors–and particularly climate-related disclosure–and its materiality to investors.

John P. Hamilton

Commissioner Peirce applauds the proposed amendments and guidance for “not bow[ing] to demands for a new [ESG-related] disclosure framework, but instead support[ing] the principles-based approach that has served us well for decades.” Citing the lack of sustainability-focused metrics disclosed in a recent sample of public disclosure filings, Peirce suggests that, “[t]here is reason to question the materiality of ESG and sustainability disclosure based on existing practices.” Further, Peirce highlights her skepticism of “calls to expand our disclosure framework to require ESG and sustainability disclosures regardless of materiality.”

Commissioner Lee, on the other hand, notes that she cannot support the proposal because the Commission has chosen to “ignore the challenge of disclosure around climate change risk rather than to begin the difficult process of confronting it.” Lee posits that investors have “overwhelmingly” made clear to the SEC, “through comment letters and petitions for rulemaking, that they need consistent, reliable, and comparable disclosures of the risks and opportunities related to sustainability measures, particularly climate risk …[and] that this information is material to their decision-making process, and a growing body of research confirms that.”  In Lee’s view, the “principles-based ‘materiality’ standard has not produced sufficient disclosure to ensure that investors are getting the information they need—that is, disclosures that are consistent, reliable, and comparable.”

Chairman Clayton, in his comments, took the opportunity to summarize steps that the SEC has taken over the last several years involving climate-related disclosure, framing the SEC’s commitment as “rooted in materiality,” and citing efforts such as the Commission’s 2010 guidance on climate change disclosure, as well as continuing engagement, both formally and informally, with market participants and non-U.S. regulators. In addition, Chairman Clayton noted certain of the challenges involved, including the “complex, uncertain, multi-national/jurisdictional and dynamic” landscape as well as the forward-looking nature of much of such disclosure, which “likely involve[s] estimates and assumptions regarding, again, complex and uncertain matters that are both issuer- and industry-specific…”

Looking ahead, Chairman Clayton highlighted two “avenues of engagement that currently are of particular interest” to him:

  1. Discussing with issuers, such as property and casualty insurers, the extent to which they use, and their experience with, environmental and climate-related models and metrics in their operations and planning, including price, risk and capital allocation decisions; and,
  2. Discussing with asset managers that have been using environmental and climate-related models and metrics to allocate capital on an industry or issuer specific basis their experience with that process.  

 De Facto Materiality – A Proposal in the ESG Disclosure Simplification Act

While several ESG-related bills have been filtering through Congress, and each will likely continue to face an uphill battle, one such bill, the ESG Disclosure Simplification Act of 2019 would address the materiality question raised in the Commissioners’ public comments referenced above by deeming ESG metrics “de facto material.” As such, the draft law would task public companies with mandatory reporting, while the SEC would be responsible for defining the relevant ESG metrics based on recommendations from the permanent Sustainable Finance Advisory Committee to be established pursuant to the law.